Kenya, China quietly strike deal on modern railway line

Monday August 19 2013

Kenya has turned to China to fund the building of a new standard gauge railway line between Mombasa and Nairobi, potentially upsetting current infrastructure arrangements with its neighbours. AFP PHOTO

In Summary

The new plan is that the Chinese-built railway will be operated under an arrangement known as “open access,” where multiple operators will be allowed to operate freight businesses on the standard gauge railway system in competition with RVR.

Kenya has turned to China to fund the building of a new standard gauge railway line between Mombasa and Nairobi, potentially upsetting current infrastructure arrangements with its neighbours.

The railway line, which is to be built according to Chinese railway design standards, will carry freight trains at speeds of up to 80 kilometres per hour, and passenger trains at up to 120 kilometres per hour.

It will be completed in five years, with the cost of the track alone estimated at a massive $2.6 billion.

Away from the limelight, the Chinese construction company — China Roads and Bridges Company — has already signed a commercial contract with the Kenya Railways Corporation, under an arrangement that commits the state-owned company to deal only with the Chinese company.

Naturally, Uganda — one of the biggest users of the Mombasa Port — as well as Rwanda and Burundi, will be following the dealings between China and Kenya closely.

The viability of the new standard gauge railway is based on the assumption that it will be part of a seamless system connecting Kenya and Uganda, and also serving landlocked Rwanda and Burundi.

The new deal will have far-reaching implications for the existing concession agreed to with Rift Valley Railway in both Uganda and Kenya.

Under the current agreement, RVR’s interests are guaranteed by clauses that stipulate that the governments of Kenya and Uganda cannot — during the tenure of the concession — introduce changes that jeopardise RVR’s profitability.

The new plan is that the Chinese-built railway will be operated under an arrangement known as “open access,” where multiple operators will be allowed to operate freight businesses on the standard gauge railway system in competition with RVR.

Kenya and Uganda could find themselves in court battling it out with RVR over access to the new railway line.

Kenya has stepped up diplomatic activity to include Uganda in its dealings with the Chinese and secure support for the new railway. Two weeks ago, the two countries negotiated a new bilateral deal on the standard gauge railway system.

Alternative routes

Meanwhile, Tanzania and Uganda have been seeking to expedite the construction of Tanga-Musoma railway line through the Central corridor in Tanzania to link Tanga and Dar es Salaam ports.

Since Kenya’s 2007-08 post-election violence, Uganda has been trying to open a reliable southern route to the coast, to avoid the recurrence of the damage to the Uganda economy witnessed then.

Kenya, an East African Community partner State, is Uganda’s main transit route.

Other major regional railway projects in the pipeline are the Juba-Malaba Railway Corridor, the Lamu-Juba Railway Corridor, and the Juba-Kampala Corridor.

What Kenya has negotiated is a typical Chinese “contractor negotiated loan,” usually supported by Chinese export credit financing.

All that remains is for Kenya’s Treasury to directly negotiate concessional export credit with any of the Chinese “policy banks” — the China Export Import Bank, the China Development Bank, Sinosure or the China Agricultural Development Bank.

Indeed, Kenya — currently implementing several ambitious infrastructure projects — is emerging as a major consumer of China’s export credit.

The number of Chinese companies aggressively chasing deals, and pitching to negotiate concessional financing on behalf of Kenyan institutions implementing large infrastructure projects, has risen sharply in recent years.

The Mombasa-Nairobi railway deal comes in the wake of the recent signing by the state-owned Kenya Airports Authority of another multimillion-dollar commercial contract with China’s Anhui Construction, to build a new airport terminal. Anhui has, on behalf of KAA, negotiated a $546 million long-term export credit to be funded by the China Development Bank.

Debt repayment

The rate at which Kenya is building up Chinese export credit in its loan book has sparked a debate within international lending circles, questioning whether the Chinese contractor-negotiated deals could lead to an unsustainable build-up in the country’s external debt portfolio.

Considering that Kenya has to raise money to service the Chinese debt and to meet its share of counterpart funding, the government is resorting to new levies and taxes on users of infrastructure facilities to raise the money to service the debts.

For instance, in crafting the funding model for the new multimillion-dollar airport terminal, the government increased air passenger tax by 100 per cent.

The new tax rate, levied on everyone who purchases an air ticket at airports managed by the Kenya Airports Authority, was introduced in April, ahead of the signing of the commercial contract with the contractor.

Last month, the Cabinet quietly gave the Kenya Railways Corporation the go-ahead to design a new mechanism that will make it possible for the government to raise the money to fund both its part of the Mombasa-Nairobi standard gauge railway project, and service the Chinese export credit.

According to a confidential memorandum prepared by Kenya Railways, an entity to be known as the Railway Development Fund will be created, financed by levies to be imposed on road and rail transport within Kenya.

Nine new revenue-raising taxes and levies are being contemplated. They include a proposal to increase the existing fuel levy so that part of the money can be channelled to the proposed Railway Development Fund.

According to the memorandum by Kenya Railways, Kenya could raise up to $9 million a year by introducing a standard fuel levy of Ksh5 per litre.

In addition, the memorandum proposes a port-traffic levy to be charged on all freight handled at Kenya’s ports.

The case for the road haulage levy is being justified on the grounds that, with the freight handled by the Mombasa Port growing by eight per cent per annum, and considering that the economies of countries in the region are also set to grow at a faster rate, the levy would raise revenues to finance the Chinese debt, and also encourage importers and exporters to transport cargo by the new railway instead of heavy trucks that take a heavy toll of the region’s roads.

There is also a proposal to introduce what the memorandum describes as “green taxes” — mainly a vehicle registration tax to be imposed on owners, as well as an insurance levy.

The argument is that these green taxes will also ease traffic congestion, reduce pollution and raise revenues for railway development.

The insurance levy will be tied to the value of each vehicle running on Kenya roads, with the amount pegged on premiums paid for insurance on every vehicle.

Additional income

Kenya Railways expects to raise even more money from selling the assets of the existing railway line.

The assumption in the financing model is that, once the standard gauge railway is completed, Kenya Railways will receive a salvage value of $41 million through disposal of the assets of the existing railway — locomotive wagons, railway tracks and sleepers.

The government believes that the existing concession with RVR will become untenable once the new Chinese-built railway line comes on board.

The financial model assumes $10 million will be raised from concession fees from two new cargo operators other than RVR.

Clearly, the challenge will be how to introduce such potentially unpopular taxes without a political blowback. Getting out of the commitments under the current concession agreement with the Rift Valley Railways may also pose legal problems.